Thursday, August 25, 2005

Surging Profits, Booming Markets
(...and Frowning Prophets?!)
Or, Is It All Too Good To Last?

Companies all over the world have been seeing bumper profits over the last year. The Economist reports that corporate profits have been outpacing GDP growth on both sides of the Atlantic, as well as in the Asia-Pacific. Business Week informs us that companies all over have surpassed profit growth expectations, and are flush with over a trillion dollars in cash. Technology companies are especially doing well - Microsoft, Dell, Intel, Oracle alone have amassed large surpluses.

What factors have led to this? Outsourcing to cheaper destinations is producing savings that go straight to the bottomline. Low-cost goods and services from China and India are keeping inflation low, freeing up spending money in consumers' hands which shows up as increased demand for all types of products that companies sell. Better use of technology is helping too, as companies have got smarter and more finicky about how well they use technology.

Meanwhile, the China-India effect* is helping produce some related, and largely pleasant, macroeconomic developments:
- the low inflation, caused by these countries "exporting deflation", is also keeping interest rates low worldwide
- thanks to more money in consumers' hands and low interest rates, people are investing in asset-building with renewed vigor - particularly in stocks and houses
- this in turn is leading to steep rises in asset prices and, most economists agree, asset price bubbles in most countries
- the resulting 'wealth effect' (people feel richer as their stock portfolios and real estate values shoot up) is further spurring consumer spending, as people spend more when they feel wealthier!

Can this last, and what can go wrong? This is admittedly a happy state of affairs. But while profits and asset prices are soaring, some worries are rising too.

- the asset price bubble can burst (or at least deflate)
- continued sluggishness and job growth stagnation in the EU countries can drag down world GDP growth
- economic policy responses from Governments need to be right (low-cost products can keep inflation low only in the short term - in the long term, only macroeconomic policy matters)
- consumer spending may slowdown in the US, the current engine of growth
- resistance to outsourcing can build up (on grounds of job losses, security concerns,...)
- worrisome or cataclysmic geopolitical events can happen (such as energy supply volatility, terrorism, nuclear arsenal buildup etc.)
- imbalances have been accumulating in the world economy, setting up stresses which may get released in unexpected ways and at unexpected times. (China's recent re-evaluation of the Yuan, although widely criticized as too little and too late, is a welcome step towards reducing one such imbalance). However even Alan Greenspan, that doyen of economic prophets, has admitted that there are forces at work in the world economy that we do not fully understand. Indian Finance Minister P Chidambaram said last week that he would be "worried" if the Bombay Stock Exchange's key Sensex did not stop its rampaging rise soon (the market duly lost some of its ardor).

If anything, all of this shows the world of business and economics has been changing - and so far, the positive effects outnumber the negatives. In general, history teaches that happy positive cycles such as the above tend to be fragile (and often too good to be true). This one looks robust, but how long it can last, only time will tell. Meanwhile, let us hope that we do all the right things to prolong the boom as long as possible, and cushion the fall when it comes.
* The China-India buzz has been getting hotter. Business Week ran a cover story on the two countries recently. Business Week's Mike Mandel is also addressing the question of how the US should perceive the two countries' ascendant R&D prowess.